Istisna'a

Istisna’a is a Shari’ah mode of financing widely used by Islamic banks and financial institutions to finance different kind of projects: housing, construction of buildings, plants, roads, etc, manufacturing of aircrafts, ships, machines and equipment, etc. It can also be used for export financing as well as to meet working capital requirements in industries where sale orders are received in advance. Banks may undertake financing based on Istisna´a by getting the subject of Istisna’a manufactured through another such contract. Accordingly, they can serve both as manufacturers and purchasers. However, Istisna´a can not be used for natural things or products that are not manufactured, such as animals, fruits, etc.
In particular, Istisna’a can be potentially used by Islamic banks to finance industries where productions can be monitored by measurement and specifications, such as in the food processing industry; or in high technology industries such as the aircraft, locomotive and shipbuilding industries, and to provide financing for the various types of machines produced in big factories or workshops. The Istisna’a contract can also be drawn-up for real estate developments on designated land owned either by the purchaser or the contractor, or on land in which either of them owns the usufruct. It involves the construction of specified buildings such as factories, hospitals, schools and universities. For Buildings that will be built and sold according to specifications, the contract of Istisna’a does not specify a particular identified place.
Nevertheless, Islamic banks need to take special care in istisna´a-based financing. They face a number of risks. These risks include Settlement Risk, Price Risk, Delivery Risk, Possession Risk and Market Risk. They use some common techniques to mitigate these risks. For example, Banks can request a proper collateral or a performance bond, they can get technical expertise in the relevant areas, they adopt a timely and effective marketing ensuring cost effectiveness, they cover themselves using Takaful insurance, or they choose creditworthy clients and by adopting suitable capital budgeting and liquidity management policies. Also, for early disposal of the goods purchased under Istisna´a contract, Islamic banks can take a “promise to purchase” from a third party or make arrangements for sale through an agency to reduce that risk.
In addition, the bank, in the position of manufacturer, must assume liability for the ownership risk prior to delivering the object of the Istisna’a to the buyer, as well as the risk of theft or any abnormal damage. It cannot absolve itself from any loss on this account.